Hidden funding risks resulting from mandatory clearing of OTC Derivs

I know I quote him a lot, but the Streetwise Professor continues to produce excellent material, and well worth reading.

Today’s post looks again at the hidden funding risks arising from mandatory central clearing for OTC derivatives in terms of the buyside firms having to post variation margin.

The gist being that buyside firms (with large directional positions) will post low quality (illiquid assets) as collateral with their large clearing banks, who will repo these out and use the cash to meet clients margin calls.

The problem with this is that in times of market stress, low quality assets will not be acceptable for repo (as Lehman’s found to its and the world’s cost) when JP Morgan and BNY Mellon refused as clearing banks to accept low quality assets to collateralize tri-party repos.

The prof is a smart guy, and importantly, he continually focuses on the unintended consequences of the OTC derivatives legislation – lets hope the CFTC reads his blog!

Anyhow, it’s another great read here

2 Responses

  1. You couldnt be more on the money

  2. I believe you are right completely

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